Debt options for senior citizens

FDs have low risk and are liquid, FMPs score on tax-efficiency.

Sixty-five-year-old Asha Chitre is happy with the recent hike in fixed deposit (FD) rates. She has good reason to be. FD rates for senior citizens are higher by 50 basis points vis a vis regular deposits. The recent spike has meant that the current FD rates for senior citizens are at 8.25-10 per cent, depending on the tenure.

And she is betting on a further rise as well. “For risk-averse people like us, this is an ideal opportunity,” she says.

She may not have to wait to invest. Bankers say customers need not wait for a rise in rates. “When the rates move up, we allow customers already invested in FDs to extend the tenure and earn the higher rate on the extended tenure,” says R Lodha, deputy general manager, retail operations, Union Bank of India.

But there is a tax element to the interest earned on FDs. The basic exemption limit for senior citizens is at Rs 2.4 lakh. After this, the tax rate applicable for incomes between Rs 2.4 lakh and Rs 5 lakh is 10 per cent. From incomes of Rs 5-8 lakh and above Rs 8 lakh, the tax rates are 20 and 30 per cent, respectively.
 

FIXED DEPOSIT RATES FOR SENIOR CITIZENS (BELOW Rs 15 LAKH)
Banks	1 years	3 years	5 years
Bank of Baroda	8.75	9.00	8.75
HDFC Bank	7.50	8.75	8.75
ICICI Bank	8.50	9.00	9.00
Kotak Mahindra Bank	8.75	9.25	9.25
IDBI Bank	9.25	9.75	9.35
Source: Apnapaisa Research Bureau

Obviously, for the senior citizen, there are three important things that have to be taken into consideration. First and foremost, risk; second, tax-efficiency and third, liquidity.

While bank FDs qualify to fulfil the first and third criterion perfectly, they do not do so well on the second one.

For the elderly, who are in the 20 per cent-plus brackets, financial advisors prefer other products because of the tax-efficiency aspect. The recommendation is a fixed maturity plan (FMP). These are available in tenures varying from five months to five years and invest in debt papers whose maturity matches the tenure offered.

According to certified financial planner Suresh Sadagopan, “FMPs that have been launched recently are investing in commercial papers and other debt products that give about 9.2-9.3 per cent returns. These are comparable to what FDs are offering.” FMPs may offer more also in many cases because they invest in higher-yielding corporate papers.

In addition, if you were to invest for slightly more than a year – say, 14 months – there are double indexation benefits. That is, if the investment was going to be made in February 2011 and the FMP matures in April, 2012, there will be an inflation indexation benefit for both the years – 2010-2011 and 2012-2013.

But, there is an issue with both liquidity and risk. Since FMPs invest in corporate paper, there is a higher element of risk. Also, the market regulator has mandated that these products have to be listed.

If a senior citizen needs to withdraw suddenly during the tenure, they will have to exit by selling at a discount. This is because there is no secondary market for these products. Therefore, FMPs are not very liquid. In comparison, exiting an FD is simple. One can simply break it for a small fee. There is a loss in the interest income, though.

One way of tackling the liquidity issue for FMPs is by opting for the dividend option instead of the growth option. This will ensure that there are steady inflows during the year. However, there is a tax at the rate of 14.16 per cent. Since the tax is deducted at the fund house level, the dividend is tax-free at the hands of the investor.

For the sake of simplicity, if one looks at investing in FDs and FMPs for a one-year period, both options are likely to give similar post-tax returns for the 10 per cent bracket. While the FD will be taxed after adding the interest income to the total income, FMPs will be taxed at 10 per cent with indexation and 20 per cent without indexation. For ones in the 20 per cent and above bracket, FMPs score on tax-efficiency but there are liquidity issues and a higher risk element.